Jason Borrevik on All You Need to Know About RSUs at Private Companies
What are RSUs?
A restricted stock unit (RSU) is a form of compensation that gives an employee the right to receive underlying company shares after satisfying the applicable vesting or performance criteria. Jason Borrevik, a Principal at Compensia, Inc., states that unlike stock options, RSUs are granted with no exercise price. At each vesting/settlement date, individuals are generally subject to tax equal to the current value of the vested shares.
Public companies often provide that RSUs over 3–4 years or upon the achievement of financial or stock price-based performance goals. Public company employees typically satisfy tax withholding liability through the disposition of shares on the open market or back to the company.
Private company employees generally must pay applicable taxes out of pocket (unless there is an accessible secondary market for company stock) which can be a significant liability / investment risk. To avoid taxation prior to liquidity, private companies may potentially condition RSU vesting on the satisfaction of both (1) time-based vesting requirements and (2) the occurrence of a liquidity event such as an IPO or a change of control.
A growing number of private technology companies are looking at whether restricted stock units (RSUs) make sense along with or in lieu of stock options. Jason Borrevik states that companies consider RSUs as part of the overall equity compensation strategy in addition to factors such as:
- Eligibility — Which employees should receive equity?
- Ongoing grants — When and why should employees receive additional awards (e.g., tied to vesting of initial awards, new financings, annual cadence)
- Grant size — What award size is appropriate by employee level and location?
- Award vesting — Recommended time or performance criteria for award vesting
- Annual burn rate and total employee ownership — How does the equity strategy look on an aggregate basis relative to market practice and investor expectations?
Jason Borrevik outlines high-level considerations related to using RSUs prior to an IPO.
Are RSUs common at private companies?
No, a limited number of technology companies broadly grant RSUs to employees prior to an IPO.
In the current environment, pre-IPO RSU usage is generally limited to select high-value (i.e., $1B+) technology companies.
Why do private companies still choose options over RSUs?
Prior to IPO, most companies do not grant RSUs due to tax and administrative challenges. Implementing RSUs requires a coordinated effort with internal and external company advisors including payroll, legal, finance, stock administration, tax and treasury.
In addition, companies may feel that RSUs are not being aligned with their risk/growth profile as there may still be a lot of perceived upside value potential with stock options.
Stock options are familiar, relatively easy to administer and flexible for tax purposes. No tax is due at vesting. Individuals can choose when to exercise after vesting and can delay exercise until the shares are liquid.
Options provide recipients with high leverage and significant potential retention value over a sustained period (typically a 10-year term from grant). Because recipients commonly receive more option shares than RSUs, they may be better off with options if company value grows.
Below we compare options and RSUs in terms of potential realizable value.
EXAMPLE: Recipient receives either 1,000 option shares with an exercise price of $5.00/share or 500 RSUs (approximate economic equivalent based on an assumed Black-Scholes ratio of 50%)
Why would a company consider RSUs prior to IPO?
Jason Borrevik states that RSUs are an extremely effective vehicle to recruit and retain top employees. RSUs are always “in the money” and never “underwater”.
At many of the higher-value private companies, employees may perceive that options are less valuable than RSUs where company valuations are speculative or have grown significantly through financings and future growth/potential may already be “priced into the stock”.
Intense local labor pressure in Silicon Valley exacerbates this perception. The top public technology companies (e.g., Google, Apple, LinkedIn, Facebook) recruit high-performing employees at all levels with significant RSU opportunities.
Companies can grant fewer RSUs than options yet deliver comparable value. Investors often appreciate that RSUs lead to lower dilution over time.
What about post-IPO?
After an IPO and the establishment of a liquid market for company stock, many Silicon Valley companies quickly transition to include RSUs in the equity mix for employees to attract/retain top talent and minimize dilution over time.
Jason Borrevik Outlines Key Takeaways
Consider RSUs in the context of your overall equity and compensation strategy.
Although RSUs are highly valued as a strong retention tool, they can be more complicated than options to implement and administer pre-IPO, particularly on a broad basis. Review the tax, administration, communication and securities law implications of RSUs with counsel to make an informed decision before implementation.
If you maintain a stock-option focused equity strategy, convey the long-term value potential of options to your employees to strengthen retention around your ongoing equity strategy.